Business Model of Costco

Costco is among the leading retail brands based in the United States. While Costco is mainly a chain of warehouse clubs, other retailers have adopted different business models. It is among the leading competitors of Walmart, the largest retail brand in the US. For faster growth, the company has been investing in digital technology and it seems to be paying off.  Costco also sells premium products under its private label brand Kirkland Signature. Similarly, there are other retailers too in the US retail industry that own several brands that are unique to the company. Costco is a popular retail brand with a strong presence across the United States which is their leading market. Costco has also built an impressive presence outside the United States in several more markets. There are several more outstanding facts to know about its business. We will analyze the business model of the Costco wholesale group in this post and what makes them successful. The United States retail industry has grown highly competitive and apart from the US-based brands, some international brands are also trying to establish themselves on a  firm footing in the market. In such an aggressively competitive market environment, retail companies need to invest in strengthening their competitive advantage in order to retain their growth momentum. 

Business Model of Costco:

Costco is a membership-only warehouse, unlike either Walmart or Target. It adopted a very different business model than other retailers. The focus was always on providing the customers seamless shopping experience and developing an organizational culture that fostered employee motivation and a focus on customer service. Apart from other things, Costco is also known for its unique organizational culture. In this way, the company has built an outstanding image and achieved a place among the leading and most popular employers of the United States. However, Costco has also been successful at expanding its presence to several major markets outside the United States.

Costco Wholesale Corporation and its subsidiaries started operations during 1983 in Seattle, Washington. The company operates in several international markets apart from the United States and Puerto Rico including Canada, UK, Mexico, Japan, Korea, Australia, Spain, France, Iceland, China. In Taiwan, the company operates its business through a majority-owned subsidiary.  As of December 2019, the company operated 785 warehouses overall. Costco added 25 new warehouses during the year including 5 relocations as well as its first warehouse in the Chinese market. The company offers an omnichannel retail experience utilizing both online and offline channels as well as delivery channels. In the US, the members that live within 20 minutes drive from the Costco warehouses can also avail of same-day delivery services. The company also continues to grow its investment and focus on e-commerce in order to support its core physical retail activities. 

How Costco makes money?

Costco generates a substantial part of its revenue from retail sales. However, apart from that, it generates a small portion of its net revenue from memberships. During 2019, the company generated $149.4 billion from retail sales and $3.4 billion from memberships. (Revenue from membership fees increased 7% compared to the last fiscal.) Compared to that Costco’s revenue from retail sales was $138.4 billion in 2018 and $3.14 billion from memberships. 

Business Segments of Costco:

Costco operates its business mainly on a geographical basis. It has divided its business into three main geographical segments that include the United States, Canada, and other international markets. 

United States: 

It is the largest market of Costco based on revenue and the number of warehouses. As of December 2019, 546 of Costco warehouses were operational in the United States and Puerto Rico while Canada had 100. The remaining of the total 785 warehouses were operational in the other international markets. Costco also runs e-commerce platforms in the United States. As of fiscal 2019, the company generated a total of $111.8 billion in net sales from the US operations compared to $102.3 billion in 2018. Its operating income from the United States market was a total of $3.1 billion compared to $2.8 billion in 2018. 

Canada:

Canada is the second-largest geographical segment of Costco based on the number of stores and net revenue. In December 2019, the number of Costco warehouses operational in Canada was 100. The company generated $21.4 billion in net revenue from the Canadian market. Apart from that, the operating income of Costco from the Canadian market was $924 million compared to $939 million in 2018.

Other International Operations: 

The operations of Costco in the markets excluding the US and Canada are included in one segment called Other international markets. These markets include Mexico, U.K., Japan, Korea, Australia, Spain, Iceland, France, and China as well as Taiwan where Costco operates its business through a majority-owned subsidiary. The other international operations of Costco generated $19.6 billion in net revenue in 2019 compared to $18.6 billion in 2018. The operating income of Costco from other international operations remained nearly flat at around $750 million for the last two fiscals.

Costco Merchandising:

Like Walmart, Costco also relies on direct sourcing to keep prices low for its customers. In this way, it has eliminated the middlemen and been able to reduce the prices of merchandise for its customers. This has helped the company gain cost efficiency which is further bolstered through the use of efficient inventory management techniques. The company sources from manufacturers directly and sends the merchandise to cross-docking units which helps it reduce the costs related to warehousing and inventory management. Apart from quality merchandise, the company also depends on lower prices to attract customers. The strategy of the brand is to provide its customers with high-quality merchandise at prices consistently lower than its competitors. The company offers merchandise in the following five main categories:

Food and Sundries:

This merchandise category includes dry foods, packaged foods, groceries, snack foods, candy, alcoholic and nonalcoholic beverages, and cleaning supplies. This is the largest segment of merchandise based on net revenue. During 2019, the company generated $59.7 billion in net sales from food and sundries compared to $56.1 billion in 2018. 

Hardlines:

This merchandise category includes major appliances, electronics, health and beauty aids, hardware, and garden and patio. This is the third-largest merchandise segment based on net sales. Hardlines generated $24.6 billion in net sales in 2019 compared to $22.6 billion in 2018. 

Fresh Foods:

This merchandise category includes meat, produce, deli, and bakery. Fresh foods generated $19.95 billion in net sales in 2019 for Costco compared to $18.9 billion in 2018.

Softlines:

This merchandise category includes apparel and small appliances. Softlines is the smallest category of merchandise based on net yearly sales. In 2019, this segment generated $16.6 billion in net sales compared to $15.4 billion in 2018.

Ancillary:

This merchandise segment includes the gasoline and pharmacy businesses of Costco.  As of 2019, the company operated 593 gas stations and gasoline sales accounted for 11% of the net sales of Costco. The ancillary businesses of Costco operate inside or next to its warehouses.  They offer expanded products or services to encourage customers to shop from Costco more frequently. The ancillary businesses of Costco include gas stations, pharmacies, optical dispensing centers, food courts, and hearing-aid centers.

The ancillary business of Costco is its second-largest merchandise segment based on the yearly net sales. In 2019, this segment generated $24.6 billion in net sales in 2019 compared to $22.6 billion in 2018. 

Merchandise2018 ($ Billions)2019 ($ Billions)
Food and Sundries$56.1$59.7
Hardlines$22.6$24.6
Fresh Foods$18.9$19.95
Softlines$15.4$16.6
Ancillary$25.5$28.6
Total$138.4$149.4
Data sourced from Costco form 10K.

Costco E-commerce operations:

Apart from being the disruptor, digital technology is also generating new opportunities for retail brands in the United States. The challenge from Amazon is growing and therefore leading retailers in the United States including Walmart, Costco and Target are investing more in technology to grow their sales and competitive position in e-commerce. 

In 2019, as Costco added more merchandise to its e-commerce operations, its website experienced growth in traffic. The company has also continued to grow its investment in technology to improve the Costco app. During the last fiscal year, the company also improved its delivery times. The company also continues to add more functionalities to its app and adding new features for higher customer convenience. During 2019, the company added new features to its app including Digital Membership Card in the U.S. and Canada, Costco Pharmacy order placement and pick-up notifications, and an option to navigate directly to member savings events. The app has been installed more than 5 million times from Google Play Store. The company is also launching e-commerce operations in Japan and Australia in 2020. At the end of 2019, the company was operating e-commerce websites in the US, Canada, Mexico, UK, Korea, and Taiwan.  E-commerce sales accounted for 4% of the company’s net sales in 2019.

Costco’s Competitive advantage:

Costco is a leading retail brand based in the United States. The company has enjoyed impressive growth in net sales and revenue over the past several years.  The business model of Costco has several strong sources of competitive advantage. In terms of retail sales, despite a limited presence compared to the leading retailer Walmart, it enjoys a strong presence in the US and is one of Walmart’s most powerful competitors. Just like Walmart’s Sam’s Club, Costco also owns a private label brand Kirkland signature which is one of the primary drivers of demand and sales as well as popularity for Costco. However, the company is now eyeing a bigger pie of the US e-commerce market and therefore continues to grow its investment in digital technology. The leading pillars upon which the success of Costco rests and that are the primary drivers of competitive advantage are discussed below:

Lower pricing:

One of the leading sources of competitive advantage for Costco is its large merchandise range that the company offers at consistently lower prices compared to most rivals in the US and international markets. One of the core values of Costco is to provide great quality goods and services at lower prices and the company has remained committed to its core value in its history. While the product range offered by Costco is limited compared to Walmart, its gross margin is also much lower than Walmart and Target. The company has designed its business model in a manner to generate most of its profits from membership fees. By keeping prices very low and using efficient inventory management techniques, the brand has managed to attract a large customer base. Most of its customers like to make repeat purchases from the warehouse retail giant which is the primary driver of sales and revenue for the company. A limited selection of nationally branded and private label products in a wide range of categories has continued to drive higher sales volume and rapid inventory turnover for Costco.

Organizational culture and HRM:

Costco is also known for its organizational culture and excellent HR management strategy. In terms of HR management and organizational culture, it has earned the reputation of a leader which is also a source of competitive advantage for the brand. Costco clearly acknowledges that its employees are an asset for the organization and the leading drivers of competitive advantage for the brand in the physical retail industry.  Apart from providing them great wages and health benefits, the company also promotes inclusion and diversity. It also focuses on employee training including leadership training and creates growth opportunities for the workers like promoting from within. The number of employees working for Costco increased to 254,000 in 2019 compared to 245,000 in 2018. Its organizational culture and focus on human resource management have also helped the company gain popularity and build a strong social image.

Private label brand:

Private label brands are also major drivers of demand and growth for both Costco and Target.  Kirkland Signature is a private label brand owned by Costco. The company has remained committed to the growth of its private-label brand Kirkland Signature and continues to develop new items and build stronger relationships with premium brands. During 2019, the company added products from Apple, Columbia Sportswear, Sony, and Weber brands to its Kirkland Signature range. The company offers a very large collection of products from Kirkland Signature. Product quality and lower pricing is key to maintaining customer loyalty for Kirkland Signature.

Product Quality: 

Another important area where Costco has maintained a consistent focus is product quality and which has continued to drive demand and customer loyalty for the business is product quality. The company sources directly from the manufacturers and also places heavy focus upon quality to attract and retain customers. A large range of good quality products is one of the main attractions of Costco and its private label brand Kirkland Signature.

Strong customer loyalty:

As a physical retail brand, the company enjoys a very high level of customer loyalty which is clearly reflected in its membership renewal rates. Its customer retention rate over the past several years has remained impressive. In 2019, the membership renewal rate of Costco was 91% in the United States and Canada. Overall worldwide, the company had a membership renewal rate of 88%. The company also continues to attract new customers worldwide through strong branding. In Shanghai (China, when the company opened its first store in 2019, it had 139,000 membership signups by the day of opening its first warehouses. The company remains committed to customer experience in order to maintain strong customer loyalty.

Costco spends nearly nothing on advertising and promotions unlike the other retailers including Walmart, Target, and even Amazon. Instead, it relies on its strong reputation, customer service, and product quality to drive demand and sales. This is a fundamental strength of Costco’s business model and a core pillar of its business strategy.  With competition in the retail industry growing all the more intense, most retail brands have grown their spending on advertising which is a leading driver of sales for most of them including Target. However, Costco still relies on strong branding to drive sales, revenue, and customer loyalty.

Supply chain and inventory management:

Supply chain and inventory management practices also decide the competitive edge of the brand in the physical retail industry. Costco sources products directly from the manufacturers in order to keep prices of the merchandise low. Like Walmart, it has also adopted innovative supply chain management practices that drive higher efficiency and help maintain consistently lower prices. It also utilizes cross-docking to keep inventory low and reduce the costs related to warehousing and inventory management.

Financial Performance of Costco over the last two years

Costco’s financial performance has grown consistently over the past several years. The net revenue of the company grew by around 8% in 2019 compared to the previous fiscal year. Net sales of the company during 2018 was $138.4 billion. Apart from that Costco generated $3.1 billion from memberships. The net revenue of the company in 2018 was $141.6 billion. It climbed to $152.7 billion in 2019 of which $149.4 billion came from retail sales and $3.4 billion from membership fees. Net sales of the company experienced an 8% growth from 2018 to 2019. 

Net income of the company experienced a growth of around half a billion having climbed from $3.1 billion in 2018 to $3.66 billion in 2019 (YoY growth of around 17%).  Of all the geographical markets of Costco, its leading market, the United States experienced the highest growth in net sales, where Costco sales grew by 9%. Canada experienced a growth of 3% and the international segment of Costco experienced a growth of around 5%.

A Few Last Words about Costco’s Business Model:

Costco has established an outstanding and string business model whose core strengths include a competitive pricing strategy and product quality. The company has found impressive growth in recent years driven by strong sales, e-commerce growth as well as higher customer loyalty. Its private label brand Kirkland signature is also an important driver of growth and competitive advantage for the brand. Moreover, Costco’s strength lies in its strong reputation and organizational culture. 

The company does not spend anything on marketing. However, despite that its sales and overall influence in the retail industry continue to grow which is mainly because of a strong business model. Instead of investing in advertising and promotions, the company focused on consistent branding and customer experience to grow customer trust.

Abhijeet Pratap

Abhijeet has been blogging on educational topics and business research since 2016. He graduated with a Hons. in English literature from BRABU and an MBA from the Asia-Pacific Institute of Management, New Delhi. He likes to blog and share his knowledge and research in business management, marketing, literature and other areas with his readers.